These authors identify low usage of wholesale funding as a key factor: read the VOXEU article here.
Category: Banking Crisis
The Irish Times has an article today by Rory Gillen of Merrion Capital. Gillen takes issue with arguments raised in a recent Irish Times article by Fintan O’Toole and also, to a lesser extent, with arguments in the 46 economist piece.
There is one argument in piece that I think is worth highlighting. It relates to subordinated bond holders. The 46 guys piece makes it clear that “certain classes of bondholders” should take a hit. Gillen presents this proposal as disastrous. He says that the
argument that bond holders should also be scalped is, in my view, a very short-sighted one. The cost of Ireland’s debt would most certainly increase, further hitting the majority of mortgage holders and businesses.
In the eyes of the international community, it would also link us to such bedfellows as Argentina, Russia and Iceland. I, and surely our descendents, would rather not be stuck with that particular stigma.
Raising the spectre of Argentina, Russia and Iceland here is unfair and, funnily enough given the title of Gillen’s article, alarmist. An Irish bank defaulting on its subordinated debt is not the same as our government defaulting on its debt (Argentina, Russia) or our banking system refusing to pay up on huge amounts of foreign liabilities (Iceland). And as for the cost of “Ireland’s debt”, some highly respected sovereign bond analysts have repeatedly pointed out that a resolution of the banking crisis in a manner that eases the burden on the taxpayer will have a positive effect on market’s assessment of Irish sovereign debt.
There is the question of the guarantee. However, some of the subordinated debt is not guaranteed while the rest is only guaranteed up until September 2010. A signal that the guarantee will not be extended for this class of assets would in no way be similar to a sovereign default.
More generally, subordinated debt is, by definition, at the back of the debt queue in terms of being paid back when a business gets into trouble. Sometimes businesses default on their subordinated debt—that’s sort of the point—and this happens not just in the countries mentioned by Mr. Gillen but also in the US, the UK and every other capitalist country in the world. We will not automatically turn into Iceland if a few subordinated bond holders don’t get their money back.
Perhaps the most contentious issue in NAMA planning is the distinction made between the long-term economic value and the current-market prices of bank assets, particularly developer loans collateralized by Irish property portfolios.
Optimists see a strong case for a liquidity-related price bounce in these bank assets, that is, low current-market prices recovering to higher “true economic value” prices over coming years, as financial market distress dissipates. This optimistic view, forecasting a bank asset price bounce, provides a strong justification for setting up NAMA, and also justifies paying the banks more than current-market prices for their bad loan portfolios (but still much less than accounting book value).
Pessimists forecast either flat or declining market prices for these bank assets over coming years. This pessimistic view implies that NAMA (if it comes into existence) should pay current-market prices or less for bank assets.
I think that the optimists might be over-extrapolating from the current US environment. There are important differences for the case of Irish bank assets. In my opinion, the market prices of US bank assets will bounce up strongly sometime during the next few years, whereas the prices of Irish bank assets will recover more modestly or not at all.
The Irish TImes has today published a letter signed by 46 economists (organised by Brian Lucey) warning against the dangers of the NAMA process. Forty six economists can’t possibly be wrong can they? 😉
On a more serious note, one of the issues that will inevitably be raised about this is the position being taken by those economists who were offered the opportunity that didn’t sign. I suspect some will argue that they must all be in favour of NAMA.
My sense, however, is that there is no alternative groundswell of support from (non-stockbroking) economists for the govenment’s approach. Rather, many people are instinctively not petition signers, preferring to express their own views in exactly their own fashion, stressing whichever nuances they think are most important. Also, it is worth emphasising that most economists are not experts in banking and finance and some simply don’t feel comfortable signing something relating to an area outside their research specialisation.
Still, if such an alternative groundswell of support did exist, I would strong suggest that they should put forward their own piece. I know that Alan Ahearne has been pressed into action but Alan is in a difficult position because publicly disagreeing with the Minister for Finance is outside his job description. I genuinely think that a high profile alternative letter, followed up by an intensive debate about the issues raised, would be very useful.
As a final note, I’d add that the headline for the article, as always, is written by the Irish Times subeditors. As far as I can see, the article says nothing about shifting wealth to developers.
Thanks to pro-NAMA commenter AL for a useful contribution in a comment thread below. I think we probably need some more pro-NAMA commenters here, at least to give Zhou some company! But seriously, AL raises some useful issues. One in particular is the question of whether we should be worried about the pricing. AL states:
If we get the pricing wrong on the way in – there is the understanding that a levy will be imposed on the banking system (affecting equityholders in the future) to recoup any shortfall on the wind up of NAMA.
I think this is worth discussing more. My worries here are (a) It’s an “understanding” rather than anything that will appear in legislation, so I have no faith that it will ever appear or, that if it does, it will be based on anything like the actual combined cost of NAMA to the taxpayer. (b) If it really becomes apparent that a levy will apply and then NAMA is running losses, this will cast a shadow over our banks for years, so that NAMA will have failed in its goal to draw a line under the problem.
Here’s a question I’d be interested in getting more discussion on. Why not have risk-sharing as suggested by Patrick Honohan’s NAMA 2.0 (pay a low price for the assets today—Patrick phrases it as “what we can confidently expected to obtain”) and then compensate shareholders (not the banks) with a share in NAMA’s potential profits, should they ever appear? This protects the taxpayer, achieves risk-sharing, and gives us cleaned up banks with no “legacy” problems.